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Ritholtz On “Ex-Post Facto Market Rationale”

While many market commentators were blaming Thursday’s declines on fears of the Federal Reserve tapering its asset-purchasing program, Barry Ritholtz is skeptical — and says the attempts to explain the declines highlight a big problem in investing.

“The issue at hand is the tendency to explain what just happened int he market after — and not before — it specifically occurs,” Ritholtz writes on The Big Picture blog. “I call this the Ex Post Facto Market Rationale, and this week’s turmoil is a perfect example of it.”

Ritholtz says this phenomenon “reflects so many human cognitive foibles all in one place”. For one thing, he says, humans love narrative, and will often thus try to explain what has just happened despite not having enough evidence to do so. For another, he says most of the day-to-day movement in the stock market is “random noise, which defies rational explanation”. He also says generally there is a lengthy lag time of months or even years when it comes to truly understanding what happened today or yesterday. But people want to “impose order on chaos, to see patterns where none exist,” he says, so they form explanations — often incomplete or erroneous explanations — of why stocks behave the way they do in the short term.

Ritholtz says he doesn’t know why the market had such a big down day Thursday, but he highly doubts it was all about the Fed and tapering. Little new information came to light about the Fed’s plans to justify such a big sell-off, he says. A potentially better explanation: “Up 16% in the first five and half months of the year is simply too rapid an ascent; we are now looking at whatever rationales after the fact — ex post facto — to justify returning to a more normalized market real rate of return.”